Tax Salience and Cyclical Asymmetry in Tax Rate Adjustments: Testing the Indirect Tax Hypothesis

Abstract

In this paper, we explore the hypothesis that politicians prefer using direct taxes with relatively high salience for tax cuts during booms, while they prefer using indirect taxes with relatively low salience for tax increases during recessions. Using a panel data set of U.S. states from 1992 to 2014, we analyzed how cyclical fluctuations in resource availability affect the statutory rates of five major state taxes: general sales tax, personal income tax, corporate income tax, and two excise taxes (gasoline and cigarette taxes). Our results suggest that cyclical improvements in resource availability during booms lead to reductions in personal income tax rates, whereas cyclical deteriorations in resource availability during recessions result in increases in general sales tax rates.